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Is Industrial Policy a Viable Model for Economic Development?

May 24, 2021
Editor(s): Anuk Kariyawasam
Writer(s): Andrew Allen, Ben Griffiths, Jade Chen

Introduction

In the wake of an increasingly inadequate Washington Consensus for achieving development outcomes, manufacturing and export-driven industrial policy have seen a resurgence as a viable alternative. This revisited paradigm for industrial development has allowed for a recontextualisation of how North-East Asian nations rose to greater economic wellbeing relative to their South-East Asian neighbours. This also raises the critical question as to whether this mode of development is viable beyond a North-East Asian context and if the contemporary economic successes of countries like Vietnam can be attributed to their industrial policies.

What is the Washington Consensus (WC)?

The WC is a shorthand for the various policies advocated for by the US treasury as well as intergovernmental organisations such as the IMF and World Bank, with the ultimate goal of achieving rapid economic development or recovering from a crisis. These policies are broad-ranging but largely consist of deregulation and privatisation, fiscal discipline, as well as liberalising trade, the financial sector, and the labour market. This framework is based on a vision of the government exclusively as a guarantor of property rights and enabler of free markets to thrive. Therefore, it follows that combining well-defined property rights and legal institutions with liberalising markets is essential to success. This is based on the belief that free markets with minimal intervention create thriving economies, which will result in greater human development downstream. 

However, the WC has not succeeded empirically as aggressive liberalisation has an extremely mixed record with respect to sustained growth or improved wellbeing outcomes for low-resource countries. Why exactly the WC hasn’t delivered results is a complex question that evades simple explanation. Some possible reasons are that it de-emphasises the important role of institutions and government initiatives in creating the foundations for growth and that it is a largely ahistorical theory that isn’t based on the actual development history of many countries in the Global North. It is this consistent failure that necessitates an alternative paradigm for development.

What is Industrial Policy?

Industrial policy is an area of controversy amongst economists with varying definitions, the most straightforward of which is supplied by Dani Rodrik: “policies that stimulate specific economic activities and promote structural change”. This form of policy typically sees development (with some exceptions) as a progression from  resource poverty to agriculture, followed by manufacturing, before arriving at a service economy with a critical role for the government to facilitate this progress. Industrial policy recognises that development inherently involves structural change and that governments can play a key role in guiding industrialists towards areas that achieve the greatest positive externalities while meeting development needs. This shift is beginning to gain greater support, with institutions like the IMF itself beginning to produce papers in the area.

Industrial policy is typically targeted towards manufacturing as it is the area that maximises the above goals and allows for broad-based and equitable poverty alleviation relative to other sectors. This is because manufacturing is an iterative process of increased sophistication that’s relatively accessible to a population with lower human capital while allowing for a “learning by doing” approach. This approach results in positive spillovers whereby knowledge, processes, and inputs can be carried over to other industries while creating cost savings and creating clusters of expertise that foster further innovation. These effects are amplified by focussing on production inputs, which then facilitate the creation of more sophisticated downstream manufacturing industries.

Having said this, it’s important to also recognise the role of agriculture in building up initial productive capacity and alleviating poverty such that a domestic market for manufacturing becomes viable.

These both exist in contrast to services, which typically require fewer people who need to already possess high human capital, which is inequality enhancing while creating fewer opportunities for positive spillovers. For an illustrative example, one can begin working in a basic factory with minimal skills and progress rapidly, whereas technology services require years of training in advance before a single product is introduced.

However, there are two critical concerns with industrial policy that need to be addressed. Information asymmetry issues can arise when governments attempt to “pick winners”, which can create a variety of distortions that result in negative externalities larger than any claimed benefits of government intervention. Moreover, there are tangible risks of corruption and rent-seeking behaviour in scenarios where governments take a more active role.

Which Policies?

In order to mitigate the challenge of corruption and regulatory capture, industrial policy needs to be pursued in such a way that it preserves and builds inclusive institutions while maintaining accountability and collaboration through a variety of mechanisms. This can be enforced by civil society activism and deep democratic engagement to ensure that governments are held accountable for delivering optimal outcomes. 

An orientation towards exports and infant industry protection is critical as it balances the need to support long-term industrial development while mitigating the risk of bloated and inefficient domestic industries by exposing firms to the competition of the international market. This is achieved through a concept elucidated by Joe Studwell known as “export discipline”. This involves orienting industrialists towards developmental aims through actively supportive industrial policy. However, it critically places incentives to export, which forces firms to learn by competing in a global market, ensuring that successful firms are rewarded and unsuccessful firms are eliminated. This results in a sophisticated manufacturing sector which can then be weaned off various incentives while facilitating further development in other sectors.

Historical Case Study: South Korea and the Philippines

Both South Korea and the Philippines experienced difficulty in kick-starting their economies following the conclusion of World War Two. South Korea, which experienced prolonged difficulty due to the Korean War, was regarded as a nation tainted by poverty and political instability that hampered economic reform (Lane, 2019). Yet, the period between 1960 – 1980, South Korea observed some of the greatest GDP growth of any East Asian country, founding its reputable status in today’s political landscape. The Philippines, however, can be characterised by a series of dramatic economic fluctuations despite its former recognition as one of the most economically dominant countries in Asia. Unable to meet the standards of growing industrial expectations, the Philippines fell behind in the global economy without the proper implementation of effective industrial policy and hence demonstrated a sluggish and slow economic growth rate in the late 20th century.

South Korea – Succesful Industrial Policy

While South Korea’s economic success can be attributed to a series of policies implemented in the late 60s and 70s, the HCI (Heavy Chemical Industry) describes a series of manufacturing-orientated strategies that sought to launch localised industries onto the international stage. Materialised by the efforts of then-president Park Chung Hee, the HCI was also of significant military interest due to the impending redaction of the United States military forces in the early 70s, which would leave the ill-resourced nation at the hands of their threatening counterparts in the North.

As a country of agricultural origin, the South Korean government took on an audacious and ambitious plan to develop world-class industrial infrastructure centred around steels, petrochemicals, automobiles, machinery, shipbuilding, and electronics – something which was largely uncommon in East Asia at the time. Trade policy and incentivised investment revealed themselves to be the main underlying themes of this industrial shift (Lane, 2019), which was actively achieved through targeted government intervention: forced mergers between competing businesses, withdrawal of production licenses from underperforming companies, state-supported subsidiaries for successful exporters and injection of new technology to the private sector. As mentioned earlier, these actions are synonymous with promoting information asymmetry amongst competing businesses. However, South Korea positioned these policies in a very broad context, allowing many businesses to exercise greater risk in the expansion of their operational activities knowing it will be backed by the government, thus promoting fierce competition. Notably, some of the most successful businesses in the current global market were able to expand in these conditions, such as KIA, Hyundai, and Samsung.

Although this is dramatically generalised for the sake of this article, the economic ramifications of the HCI were outstanding and revolutionary – generating an annual economic growth rate of over 10% for much of the late 70s in South Korea. With the continued dominance of these brands in the international market today, it’s not difficult to observe the success of South Korean manufacturing on a frequent basis, an amazing turnaround from such humble origins.

Philippines – Failures of No Industrial Policy

Impeded by mismanagement, corruption, and an inability to enhance manufacturing policy (Sachs et al, 1989), the Philippines slowly began to lose grip on their once-dominant, pre-war position in Asia. Political instability and a lacking effort to explore the economic potency of industrialisation primarily characterised the downfall of the Philippines when compared to a country like South Korea. One of the most notable and differing aspects between any economically dominant Asian country during the 70s (Taiwan, Korea, Japan) and the Philippines is their capacity to produce steel and iron. While these countries were fostering a competitive domestic market and encouraging the investment in export industries, the Philippines was, in many ways, remaining complacent with their raw material outputs which sat at 76% of their exports in the early 70s, yet dropped to 46% by the end of the decade. Studwell notes in his book ‘How Asia Works’ (2013) that the Philippines simple made no effort whatsoever to promote industrial manufacturing.

This became a defining feature between countries exhibiting a strong economic growth rate, and those that did not. Coupled with an ineffective and corrupt government under the leadership of President Ferdinand Marcos, the nation’s industrial policy of the early 70s was overshadowed by an ever-increasing level of national debt. Even in the 80s, the poor management of economic policy and trade deals gave way to more loans from the World Bank, decreasing the net level of exports and increasing net imports (Hays, 2008).

As such, it’s no wonder why countries that promote and support the expansion of domestic businesses onto the global scene, such as South Korea, seem to have developed significantly compared to those that lacked a concrete set of policies related to industry manufacturing and international trade.

Vietnam: A 21st Century Case Study

In light of the successes demonstrated by South Korea and the failures experienced by the Philippines, the rising manufacturing nation of Vietnam presents a perfect contemporary example of economic development to study. Therefore, the subsequent paragraphs will address some key policies and reforms, in addition to drawbacks faced by Vietnam during recent decades.

Vietnam, like South Korea, embarked on a manufacturing-led development that began under the implementation of industrial policies with respect to the Doi Moi Reforms in 1986. The industrial policies under this reform aimed to promote the decentralisation of state power, and hence increase the capacity for Vietnam to embark on a journey to achieve a more market-oriented and open economy, which was largely needed at the time to improve its economic conditions. By allowing for a faster expansion in its labour pool in conjunction with removing barriers for enterprise growth, productivity for the expansion of the manufacturing industry was enhanced, laying the foundation to accommodate exports. Furthermore, following the establishment of the 2005 Enterprise Law, there has been an even larger decrease in state-owned enterprises accompanied by an increase in privately-owned businesses as well as economic growth. 

The Benefits of Vietnam’s Industrial Policy

At the same time, the Vietnamese government had also recognised the importance of international trade, and thus implemented changes to 60 legal documents in order to administer the commitments for a relationship to be established with the WTO in 2007. This greatly aided Vietnam in achieving a more liberalised economic structure which permitted Vietnamese exports to thrive. Currently, the foremost exports for Vietnam comprise machinery, textiles as well as readymade garments, which supports a distinct portion of the country’s export revenue, and the garment manufacturing sector alone, employs 2.5 million Vietnamese citizens. Since employment opportunities suited to Vietnam’s population demographics rose, there was consequently an increase in aggregate demand which further established Vietnam’s position as an emerging manufacturing hub. As a consequence, due to the economic and social benefits reaped from industrial reform, Vietnam is continuously narrowing the existing gaps in its manufacturing progression in comparison to top South-East Asian countries such as Singapore and Thailand from 2006-2016

Accordingly, a significant point to address includes a comparison to South Korea’s journey to arrive at its position today. As a general reflection, it is observed that there are some similarities between the two countries’ industrial reforms in the sense of liberalising the economy to foreign trade and exporting manufactured goods. However, the key difference encompasses the fact that South Korea has taken an approach to technology development and production, as well as spending an extremely large share of the country’s GDP to invest in research and development. This is in contrast with the progress of Vietnam at the time as they had primarily focused on machinery and garments production for example.

The Downsides of Vietnam’s Industrial Policy

Concurrently, it should be acknowledged that there are variously indisputable downsides regarding Vietnam’s industrial policies and rapid industrialisation that are not confronted by South Korea to a large extent. To enhance its current development, Vietnam may consider expanding its low margin manufacturing operations to encompass more technological progression. In accordance, a recent McKinsey report has also advised of expansion into more sectors to perpetuate Vietnam’s development, specifically revealing that a 50% increase in labour productivity growth is required to sustain Vietnam’s current productivity levels. For this reason, if the current weighting for each sector remains, the productivity target may not be met in the future. Furthermore, additional pressing issues to be resolved include the questionable working environments for workers within Vietnam’s industrial and manufacturing sectors. Since collective bargaining and wage negotiations are rare despite a lack of overtime pay, the wages of labourers in the garment and footwear industry are typically less than 25% of the typical living wage and are not just or egalitarian. This, in addition, may lead to considerable negative impacts on Vietnam’s long-term workforce productivity, and the consequences of this should be carefully scrutinised before further actions.

Conclusion

Ultimately, the success of industrial policy in its various forms in South Korea holds a riveting argument against the traditional Eurocentric policies proposed by the Washington Consensus. Industrial policy, by securing budding industries from being crushed by foreign competition, was able to propel South Korea to levels of success far outshining the more traditionally managed Philippines. Vietnam, a more recent case study, offers a different perspective where, while industrial policy has significantly aided it in achieving high levels of economic growth, it may struggle to raise standards of living in the future if it doesn’t rapidly diversify into other sectors. In conclusion, while industrial policy isn’t a perfect solution that will satisfy every need for developing nations in the modern era, it does produce a historically viable alternative to more traditional liberal models of economic development.

References

The CAINZ Digest is published by CAINZ, a student society affiliated with the Faculty of Business at the University of Melbourne. Opinions published are not necessarily those of the publishers, printers or editors. CAINZ, our Partners and the University of Melbourne do not accept any responsibility for the accuracy of information contained in the publication.

Meet our authors:

Anuk Kariyawasam
Editor

I'm a Bachelor of Commerce student in my penultimate year majoring in Economics and Management. My key interests are macroeconomics and technology. As an editor at Cainz, I hope to produce insightful, meticulously researched articles on a wide range of topics.

Andrew Allen
Writer

My name is Andrew Allen and I am currently studying a Bachelor of Commerce at the University of Melbourne, with an interest in Finance and Management. I thoroughly enjoy writing about commerce-related topics, and as such you will find me writing articles in the CAINZ Digest section !

Ben Griffiths
Writer
Jade Chen
Writer